An issuer might have a number of different financial instruments outstanding at the same time. For example, an issuer could have five different bonds outstanding, each bond being due on a different date. The complex and unusual structure of such debt can sometimes lower the perceived worth of any future bonds that might be issued.
To address this problem, it is known that a bond exchange can be held to swap the old bonds with a newly issued bond. FIG. 1 illustrates a known bond exchange 100 in which a client 120 provides “eligible issues” (i.e., the old bonds) to an issuer 110 in return for a “new issue” (i.e., the new bond). In this way, the issuer 110 can consolidate debt (e.g., by replacing ten outstanding bonds with a single new bond). The issuer 110 may also use the bond exchange as a way of extending debt.
Note that different clients 120 might have different opinions as to the worth of the new bonds as compared to the old bonds. As a result, clients 120 can submit offers, referred to as letters of transmittal, to the issuer 110. For example, the bond exchange 100 might be structured as a “forward” exchange (in which clients 120 submit bids on the value of old bonds to be exchanged for a fixed amount of new bonds) or a “reverse” exchange (in which clients 120 submit bids on the value of new bonds to be exchanged for a fixed amount of old bonds). In either case, the client 120 might submit an offer that indicates, for example, a bid price (or a spread to a reference instrument) along with a number of bonds he or she is interested in exchanging. The issuer 110 then executes the exchange with the clients 120 who submitted the most appropriate bids.
The bond exchange process, however, can be difficult to perform. Consider two clients who both submit identical letters of transmittal to an issuer that wants to issue fifteen thousand new bonds. In this case, the issuer might allocate new bonds on a first-submitted, first-allocated basis. For example, if a first client submits an offer to exchange ten thousand bonds while a second client later submits an offer to exchange twenty thousand bonds (at the same price), the issuer would allocate ten thousand new bonds to the first client and five thousand new bonds to the second client.
As another approach, the issuer might allocate new bonds on a pro-rated basis in accordance with on the number of bonds associated with each offer. For example, if a first client submits an offer to exchange ten thousand bonds while a second client later submits an offer to exchange twenty thousand bonds (at the same price), the issuer would allocate five thousand bonds to the first client and ten thousand bonds to the second client (i.e., the second client would receive twice as many new bonds). The complexity of such allocations will grow as the number of eligible issues, new issues, and/or clients increases.
Moreover, even a small error in a letter of transmittal and/or the allocation process can have serious consequences, especially when a significant amount of value is associated with the bond exchange.